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Freedom's Phoenix

How Inflation Happens and Why It's Bad

November 2, 2008 - 12:00am
Nick Coons by Nick Coons

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We're all aware of inflation's existence, and if we've been around for awhile we know that "I used to buy (name of some item) for a lot less when I was a kid." Most people have accepted inflation as a natural occurrence, and understand that as along as their own income continues to increase to match the rate of inflation then everything will be fine.



On the contrary, the inflation that we see year after year (known more specifically as "monetary inflation") is anything but natural.  It's completely a function of an increased money supply by the Federal Reserve.  And on average, your income will never keep up with inflation.

The Tale of the Island Currency
Imagine you were one of one-hundred people living on an island, and everyone would specialize in what they were good at.  Several people might be good at growing crops, others good at cooking, some could build shelters, and so on.  Each person would want to receive something for their efforts otherwise those efforts might be taken advantage of.  A direct barter system would be difficult to maintain.  You may build shelters, and need crops from someone who grows them, but that person may not need you to build them a shelter.  How would you get your crops?

Most likely the inhabitants of your island would setup some sort of currency system.  For instance, let's say that you found a pile of clear rocks and divvied them up evenly such that each person had an equal number of clear rocks.  You could give a crop grower a clear rock in exchange for some crops, and he could then use that clear rock to give to someone else in exchange for something he needed.  Someone charging too much would find that no one would give them clear rocks for what they had, and someone charging too little would not be able to keep up with the demand for their products or services.  So the number of clear rocks needed to purchase a specific product or service would work itself out naturally.  A system such as this would work well, because it would insure that no one would consume more than they could produce and putting an undo burden on their neighbors.

Imagine now that one person on the island began exploring and found a pile of previously undiscovered clear rocks.  These are rocks that no one else knows about, so he keeps his discovery to himself.  With his new-found "wealth", he begins purchasing more and more from his neighbors.  At first, no one notices the increased number of clear rocks, but eventually they do.  People start to realize, "Hey, I have more clear rocks then I used to," and they begin purchasing more than they were before.  This causes prices to increase because of the increased demand.  This is inflation.

So what's the problem?  It may not be obvious at first, but you may have noticed that there's a time lapse from the point where the new clear rocks were discovered and used, and the point where prices began to rise.  The person to get his hands on the new clear rocks first had the advantage of being able to spend them when prices were low.  By the time these clear rocks made it into the hands of others, prices had increased.  If inflation had set in immediately and everyone got the new clear rocks at the same time, then higher prices and higher incomes would have been a clean wash.  But because of the time lapse, the person to get the clear rocks first was at an advantage, and has purchased and consumed products and services at the lower prices.  Likewise, the people to get the new clear rocks last had to purchase items at higher prices before they had access to the new clear rocks.  If this happened over and over again, this person could easily become very wealthy at the expense of others.

Back in the real world, this is very close to how the Federal Reserve works.  The Federal Reserve creates new money, which is lent out to certain individuals and groups.  These borrowers get to spend the money at today's prices.  Once the money is spent, inflation sets in.  By the time the rest of us get our hands on it, prices have gone up.  The increased price is a result of the increased money supply created by the Federal Reserve.  In this way, wealth is transferred from the lower and middle classes upward.

When we look at the cost of everything, including food, education, health care, energy, and housing, almost all of these increased costs over the years can be attributed to the Federal Reserve's policies of creating inflation.  As government spending and deficits increase, we can look forward to more inflation in the future, somewhat proportionate to the deficits (i.e. more deficits = more inflation).

The only fix to this problem is to rid ourselves of the Federal Reserve and allow the market to choose what to use as currency.  There is no need to outright abolish the Federal Reserve.  All that is needed is to legally allow people to choose their own currency, and the Federal Reserve will become obsolete on its own.  Who would choose to hold their savings in the continually declining currency known as Federal Reserve Notes?



Related Content:

Financial Bailout - Nick Coons
The Immorality of Coercion: Monetarism Edition - Ross Kenyon
Can We End the FED? - Nick Coons


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